Best Small Business Loan Options
An overview of the different lending products available to SMBs
The Problem
Everyone knows the stats about small business failure rates in America but how about this one anon. 29% of SMBs failed because they ran out of cash. Whether you like it or not, if you’re running a small business the odds are that you will need outside capital at some point. By some estimates, 56% of SMBs applied for a loan taking out a combined $645 billion in 2019 (source). As Michael Scott says -
To make matters worse, the SMB lending landscape is a viper pit filled with shady brokers and marketplaces that call themselves “product agnostic”. In reality these players are incentivized to drive you towards products that generate the most revenue for themselves. Some lenders offer broker commissions as high as 17% on the loan amount (source). If brokers are getting 17% you don’t want to know what rates they’re charging you.
The Solution
The good news is this little cat, BowTiedOncilla (BTO), is here to ensure you have all the necessary information when you are searching for a small business loan. I have over a decade of experience working in, with, and building small businesses with the last few years spent at an SMB lender holding several different positions (hopefully I didn’t just dox myself). I even spent 3+ years operating my own e-com business so I intimately know the struggles of getting capital as a small business owner.
The Products and Lenders
In this stack I’ll be walking you through the main types of SMB lending products, analyzing the pros and cons, and sharing links to BTO vetted lenders. This is by no means an exhaustive list. My goal is to give you unbiased, unadulterated information so you can make the best lending decision for your business, your employees, your customers, and you. If you have any questions feel free to leave them in the comments or reach out to me directly on Twitter @bowtiedoncilla. Last but not least, I think this is where I’m supposed to say this is not financial advice, for educational and entertainment purposes only.
What We Will Cover - Lending Products
Bank/SBA Loans
Term Loans
Working Capital Loans
Business Line of Credit
Equipment Loans
Invoice Factoring
Invoice Financing
Merchant Cash Advances
Bank/SBA Loans
Traditional banks and SBA backed lenders offer a variety of lending products, however for the sake of this stack I’m referring to their term loans as this is the most common type of lending vehicle. The SBA 7(a) is the flagship lending product offering SMBs loans up to $5M and payback periods up to 10 years. The SBA 7(a) is a fully amortizing term loan meaning a portion of each payment goes towards principal and interest with the loan paid in full on the last payment. Borrowers receive a lump sum up front and make monthly payments until the loan is paid in full, just like your mortgage or car loan. The SBA guarantees up to 85% of the loan principal allowing lenders to provide the most competitive rates in the market. In addition to the 7(a) standard loans, the SBA offers several variations and offshoots of this product. You can learn more about the various options on the SBA’s site.
Minimum Eligibility Requirements
Operate for profit
Be engaged in, or propose to do business in, the U.S. or its territories
Have reasonable owner equity to invest
Use alternative financial resources, including personal assets, before seeking financial assistance
Lenders may have their own, stricter eligibility requirements
Pros
Typically have the lowest APRs
Prime + premium but not to exceed the SBA maximums
Long term lengths (up to 10 years)
Monthly payments
Cons
Long application process
Often weeks if not months
Often have the highest credit requirements
Long business tenure, positive EBITDA, higher DSCR
Strict collateral requirements
Including but not limited to personal real estate
May have variables rates
Payments can change with the federal funds and prime rates making it more difficult to budget
Best Uses
For those that meet the higher eligibility requirements and have a use of funds that isn’t immediate
Businesses that want to reduce cash flow burden via shortest APRs and longest term lengths thus lower payments
Refinancing existing business debt
Projects that require large amounts of up front capital and/or with longer payback periods
Business acquisition, remodeling your office or brick and mortar location, new product development, etc.
Lenders
If you have an existing business relationship with your bank this is your best bet
If you want an SBA 7(a) you’ll need to go to an SBA approved lender
If you want to learn more about SBA 7(a) loans, read my deep dive article here.
Term Loans
These products are very similar to SBA/Bank loans but offered through online or non-traditional lenders. By going with these lenders you will often trade speed and ease of application for higher rates/fees than the banks or SBA products.
Pros
Often the lowest APRs outside of banks
Longer term lengths vs other non-traditional lenders
Up to 12 years
But often in the 5-10 year range
Fixed, monthly payments
Collateral not required
Quicker speed to funding vs banks/SBA loans
Days vs weeks/months
Simplified documentation requirements and application vs banks/SBA loans
Cons
Higher credit requirements but typically less than banks/SBA
More required documents than shorter term options
Personal guarantee and/or UCC filings in lieu of strict collateral requirements
May come with higher fees
Best Uses
For businesses that don’t meet the strict credit requirements of banks/SBA loans but want longer term lengths and lower APRs
Some bank/SBA eligible businesses may opt for this product due to quicker speed to funding
Great for projects that require large amounts of up front capital and/or with longer payback periods
Lenders
Working Capital Loans
Working capital loans are structured similarly to traditional term loans where you receive a lump sum up front but with shorter term lengths and often more aggressive payback terms (daily or weekly payments). With shorter term lengths and more aggressive payment terms these loans are best for everyday business expenses instead of larger projects.
Pros
Quicker speed to funding vs banks/SBA
Less paperwork/documentation
Lower credit requirements than term loans, bank, and SBA lenders
Cons
Shorter term lengths (up to 2 year)
Often have daily or weekly payments
Often have higher APRs vs traditional term loans, banks, and SBA lenders
Best Uses
For businesses that need quick cash on a short term basis to meet everyday business expenses
Payroll, rent, utilities, etc.
Covering slower periods (seasonal businesses) or one off cash flow gaps
Lenders
Business Line of Credit (BLOC)
Similar to a credit card, a BLOC provides access to a predetermined amount of capital that can be withdrawn on an as needed basis. Fully revolving BLOCs replenish as you make payments ensuring a continuous source of capital. Some lenders treat every draw as a separate loan with its own amortization schedule. Others re-amortize the loan with every draw meaning you keep one payment regardless of how many times you draw.
Pros
Flexible, continuous source of funding
Pay interest/fees only on the amount drawn (borrowed)
Quick speed to funding and less paperwork
Some lenders require only 3 months of bank statements
Cons
Shorter repayment periods (6-12 months)
Banks may have different structures/repayment periods
Personal guarantee and/or UCC filings in lieu of strict collateral requirements
Beware of fees
Draw fee every time you draw down the line
Maintenance fee just for having the line open, sometimes in place of a draw fee
Inactivity fee for not using your line
Best Uses
Projects with undetermined costs
Businesses that have recurring cash flow gaps - mismatch in timing of funds coming in vs going out
Payroll, accounts payable, inventory, etc.
If you are in e-com or an Amazon seller you should consider a BLOC to ensure you never run out of inventory
Lenders
Bank is your best bet if eligible
Equipment Loans
Often structured as a term loan with a specific piece of equipment acting as collateral for the loan. If the borrower defaults, the lender can repossess the equipment to satisfy the loan obligation. Once the loan is paid in full, the borrower will own the equipment free and clear. Since the loan is collateralized they often have lower APRs vs traditional term loans.
Pros
Lower APRs
Longer term lengths
Upwards of 20 years depending on the lender and equipment
Equipment financed serves as collateral
Equipment vendors may offer in house options or through a ‘trusted partner’
Cons
Borrowers may not be able to finance the entire amount of the equipment so they will need to provide some of their own capital
More paperwork and slower speed to funding depending on the lender
Best Uses
For large equipment or similar capital expenditures
Lenders
For larger loan amounts your bank may be the best option
Invoice Factoring
Invoice factoring is technically not a loan. With this financing source ‘borrowers’ sell their B2B invoices to a third party at a discounted rate, typically 70%-95% of the total invoice value depending on the credit quality of your customers. ‘Borrowers’ receive the remaining funds minus a fee once invoices are collected. There are 2 main types of invoice factoring 1) Recourse factoring means you have to buy back unpaid invoices. 2) Non-recourse factoring means the factoring company incurs the liability of unpaid invoices but often comes with higher fees.
Pros
Quick speed to funding
Typically have lower credit requirements than other lending options
Cons
Can be very expensive
Often comes with lots of fees, often hidden
Loss of control over relationship with your customer as the factoring company owns your invoices
Best Uses
For businesses that have lots of outstanding invoices with no access to other sources of lending
Lenders
eCapital (non-recourse)
OTR Solutions (Freight)
Invoice Financing
Similar to invoice factoring except borrowers don’t sell the invoices thus maintaining control over the relationship with their customers. The invoices are used as collateral to secure a cash advance. When the invoices are paid, you must pay back the loan.
Pros
Quick speed to funding
Typically lower credit requirements than other lending options
Maintain control over the relationship with your customers vs factoring
Cons
Can be very expensive
Often comes with lots of fees, often hidden
Best Uses
For businesses that have lots of outstanding invoices with no access to other sources of lending
Merchant Cash Advance (MCAs)
MCAs are also not technically loans. MCAs allow businesses to sell their future credit/debit card sales in exchange for a lump sum cash advance. The MCA company takes a percentage of your sales until the advance amount and predetermined ‘fee’ is paid in full. When structured this way, the MCA is connected directly to your credit/debit card processor so that money never reaches your bank account. Some MCAs are structured like working capital loans where they take a fixed $ amount daily or weekly from your bank account.
Pros
Quick speed to funding
Cons
Higher APRs - not subject to any regulations on interest rates since they aren’t considered loans
Best Uses
Basically none
Only in pinch but you’re probably better off going any other route
Lenders
We will never recommend MCAs to any business
Summary
Well there you have it folks. A somewhat comprehensive overview of the business lending landscape covering the main product types.
The plan for this stack is to write separate articles diving deeper into each type of product. We’ll then do a comparative analysis of each BTO vetted lender under each product type.
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